A Second Betrayal

A SECOND BETRAYAL By : By Max Baucus, Charles E. Grassley and John McCain

March 13, 2003 - Wall Street Journal - The public's stake in U.S. companies is more important to our economy than ever before. Almost half of all households own stock, up by 60% in the past 15 years. But the corporate meltdown has caused investors to lose confidence in the stock market. This January, individual investors withdrew a net $1 billion from mutual funds -- the first instance of net outflows during the typically bullish month since 1990. To address investors' loss of faith in the market, Congress passed the Sarbanes-Oxley Act. But it applies solely to future corporate activity. To more fully restore investor confidence, state and federal regulators are also working to hold accountable those whose acts gave rise to Congress's corporate reform legislation in the first place.

One significant attempt to restore integrity by punishing corporate wrongdoers is the global settlement agreement that New York Attorney General Eliot Spitzer, former SEC Chairman Harvey Pitt and state securities regulators reached with several premier Wall Street securities firms late last year. That "handshake agreement" is designed to tackle the influence that the firms' investment bankers allegedly imposed on their analysts, encouraging them to give overly positive ratings to corporate clients of the firms' investment banking units.

Over the last two weeks, this newspaper and others have reported that the firms may be able to recover a significant portion of their payments from their insurers or deduct those payments from their taxes. Although the SEC has disputed this, it's been reported that by avoiding the use of words like "fraud," over $1 billion in payments made by the firms under the agreement might be made insurable or tax-deductible. To the extent that any portion of the settlement payments is paid by the firms' insurance policies or deducted from their taxable income, insurers, other insureds, and taxpayers will be left picking up the tab for corporate wrongdoing.

This is unacceptable. If the final settlement permits firms to deduct their payments from their taxes or pass any portion of the payments to their insurers, its deterrent effect and punitive value will be eviscerated. In testimony before the Senate Commerce Committee last year, Mr. Spitzer indicated that joint investigation of the firms was needed to restore investor confidence in the integrity of the marketplace. In what we understand is its current form, the agreement could instead reaffirm cynicism among investors about the market's integrity.

Given the magnitude of the settlement, the agreement might also affect thousands of publicly owned companies that have professional liability insurance. Their premiums could rise significantly as insurers pass on costs to consumers. With lower or no insurance coverage, such companies may find it difficult to retain or attract well-qualified directors -- a key to effective corporate governance.

The SEC has suggested that matters such as the tax treatment of settlement payments fall outside its purview. Only an overly narrow reading of the laws that established the SEC and govern its conduct supports such an interpretation. The proper view is one that fully embraces the SEC's duty to protect investors and punish corporate wrongdoers. This view acknowledges the stake that individual investors now have in the market -- a stake that, in the words of confirmed SEC Chairman William Donaldson, represents those investors' hopes, futures, and security.

There's a lot still to be done, but we pledge to continue doing everything within our legislative and oversight powers to secure the reform of corporate America, and to restore investor confidence in the integrity of the marketplace.

Messrs. Baucus, Grassley and McCain are U.S. senators.